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FRM Part II · FRM Exam Part II · The Global Drivers of Private Credit

A regional bank has cut direct middle-market lending after capital rules tightened but now extends back-leverage (credit lines) to private credit funds that make those same loans. Which assessment of the bank's risk position is most accurate?

Exposure is indirect but real, through fund leverage and potentially correlated drawdowns, and may be less transparent than direct loans. The bank still depends on middle-market credit quality because losses at funds can impair repayment of its credit lines and trigger simultaneous liquidity demands.

  1. ACredit risk has been fully transferred to the funds, so the bank has no exposure to middle-market credit quality
  2. BExposure is now indirect, via fund leverage and potential correlated drawdowns, and may be less transparent than direct loan holdingsCorrect
  3. CRisk is lower in every respect because fund loans are senior-secured and funds are unlevered
  4. DThe bank's exposure is solely to interest rate risk, not credit risk

Explanation

Lending to funds keeps the bank linked to underlying loan performance through fund losses, margin or covenant triggers and liquidity drawdowns. Exposure is often less transparent and can be correlated across funds. It is not fully transferred, and the funds are often levered.

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